2 Conceptual Differences Between FC & SEAccounting Theory ( 5th edition)Wolk, Tearney & DoddCopyright June, 2000Conceptual Differences Between FC & SEBoth methods are allowed under GAAPBoth present as assets only the costs incurred in exploration and developmentBasic difference is the size of the cost center used in the capitalize/expense decision for exploration costsUnder FC, the largest possible cost center is the country or even a continent, and all costs of finding oil and gas reserves would be capitalized regardless of whether a specific local effort is successful.Under SE, the smallest possible cost center is the property (lease), reservoir, or field (most SE companies use the field), and all costs of that well would be expensed unless oil and gas reserves are found.SE embodies finite uniformity: if exploration is unsuccessful, exploration costs are expensed; however, when successful exploration occurs, costs are capitalized.Chapter 15Oil & Gas Accounting

3 Accounting Theory ( 5th edition) Wolk, Tearney & DoddCopyright June, 2000TrendsSE accounting was the only method used prior to the late 1950s and early 1960sProblems with application of the historical cost model led to increasing use of FC model in late 1960sProblem with application of FC model: frustration with a historical cost concept that penalizes enterprises for exploration efforts that result in no discoveries and does not reward those efforts that result in discoveries with recognition of the value discoveredChapter 15Oil & Gas Accounting

4 Accounting Theory ( 5th edition) Wolk, Tearney & DoddCopyright June, 2000Full Cost AccountingResults in a smoothing of reported income because costs that are written off in the current period under the SE method are capitalized and amortized against revenues of a number of future periodsGenerally, the larger, more mature and fully integrated enterprises in the oil and gas industry use SE, while the smaller, less integrated enterprises use FCChapter 15Oil & Gas Accounting

7 Standards Setting in Oil & GasAccounting Theory ( 5th edition)Wolk, Tearney & DoddCopyright June, 2000Standards Setting in Oil & Gas1972, SEC proposed that those enterprises that do not follow SE should disclose what net income would have been under that method ... later retreated from proposal1973 foreign oil embargoThe Energy Policy and Conservation Act of 1975Chapter 15Oil & Gas Accounting

8 Standards Setting in Oil & GasAccounting Theory ( 5th edition)Wolk, Tearney & DoddCopyright June, 2000Standards Setting in Oil & GasFASB worked closely with the SECIssued a discussion memorandum in 1976Held a public hearing in the spring of 1977.July 1977, the FASB issued an exposure draft, which required the SE method of accountingSEC issued ”Securities Act Release No. 5861,” which proposed to amend regulations to incorporate the accounting standards set forth in the exposure draft in the event a statement of financial accounting standards was not issued ...Chapter 15Oil & Gas Accounting

12 Accounting Theory ( 5th edition) Wolk, Tearney & DoddCopyright June, 2000RRA Valuation MethodEstimate the timing of future production of proven reserves, based on current economic conditionsEstimate future revenue by using estimate from (1) and applying current prices for oil & gas, adjusted only for fixed contractual escalations.Estimate future net revenue by deducting from the estimate in (2) the costs to develop and produce the proven reservesDetermine the PV of future net revenue by discounting the estimate in (3) at 10 %Chapter 15Oil & Gas Accounting